Foreword
By Annabel Brodie-Smith
Last week the Alps came to Oxfordshire for a couple of days and much to my children’s delight, it was lovely sledging weather! Snowballs rained down and a snowman took pride of place in our garden.
It was a welcome relief from the never-ending Brexit negotiations… This month we are looking at Venture Capital Trusts, more commonly known as VCTs. VCTs’ perspectives on Brexit are thought-provoking as they are at the coalface of the UK economy investing in small, unquoted companies which are high risk but can grow into household names generating economic growth and jobs. VCTs are concerned about the status of Europeans working in the UK but generally are not so worried about exporting to the EU as they believe it has always been difficult to sell to EU countries.
Please do watch the video where I talk about the potential effects of Brexit and where VCTs are investing with John Glencross from Calculus VCT, Ian McLennan from Triple Point VCTs, and Rodney Appiah from Foresight VCTs. We also have an article gathering VCT manager views on smaller company opportunities and the outlook for the sector.
Of course, it’s important to understand that VCT investors who invest in high risk young companies are compensated by the Government with generous tax breaks. It won’t surprise you that our savvy investment expert, Ian Cowie, has been making full use of these VCT tax benefits. He analyses the benefits and risks of investing in VCTs in his column this month.
John Glencross - Calculus VCT, Ian McLennan - Triple Point VCTs, and Rodney Appiah - Foresight VCTs, discuss the impact of Brexit and the themes in their portfolios.
Finally, with Chinese New Year ushering in the year of the pig we have taken a look at China, the second biggest economy in the world. We have spoken to investment company managers with significant holdings in the region about trade wars, slowing growth and the prospects for China.
Hope the year of the pig proves a lucky one for you.
Annabel Brodie-Smith
Communications Director, AIC
From acorns to oaks
VCT managers reveal where they're finding green shoots of opportunity despite Brexit uncertainty
Uncertainty around Brexit has hit UK markets and raised questions about the UK’s economic prospects, but what effect is it having on the UK’s smaller unquoted companies? Despite a tough year, the average VCT returned 2.7% in 2018 and is up 42% and 163% over five and ten years. Where are VCT managers finding opportunities today and what are their views ahead of Brexit?
On Tuesday 29th January the AIC held a media roundtable on VCTs. John Glencross, CEO of Calculus Capital which manages the Calculus VCT, Ian McLennan, manager of the Triple Point VCTs, and Rodney Appiah, director of Foresight which manages the Foresight VCTs, discussed their recent investment activity, the potential effect of Brexit on smaller companies and their overall outlook for the sector.
John Glencross - Calculus VCT, Ian McLennan - Triple Point VCTs, and Rodney Appiah - Foresight VCTs, discuss the impact of Brexit and the themes in their portfolios.
Their views have been collated alongside comments from David Hall, managing director of YFM Equity Partners which manages the British Smaller Companies VCTs, and Jo Oliver, manager of Octopus Titan VCT.
Brexit’s impact on smaller companies
Ian McLennan, manager of the Triple Point VCTs, said: “When it comes to Brexit, the main concern we are hearing from portfolio companies is around people. Tech-related companies in particular often have a significant number of EU nationals in their team. One portfolio company has reported that they have already seen a 50% reduction in job applications from EU nationals after the 2016 referendum result. In time we expect that this will be mitigated by clarity on the rules around EU immigration for skilled workers, by increased immigration from non-EU countries and by up-skilling UK citizens. On a more positive note our healthcare-related investments are anticipating that Brexit will result in more money being spent by the NHS.”
David Hall, managing director of YFM Equity Partners which manages the British Smaller Companies VCTs said: “There’s a difference between the short and long-term effects of Brexit. The current process is just creating short-term uncertainty. That makes any sort of long-term planning more difficult.
“What we have seen in our portfolio is those businesses who move physical goods across borders step up contingency planning, which in many cases means finding other ways of getting their goods to overseas markets, for example offshore inspections or quality control centres or final assembly outside the UK. These are temporary measures for now but could be made permanent if needs be.
“For those businesses delivering services it’s not quite business as usual, but there is less thought about tomorrow and more about the long term. At this stage the long-term impact of Brexit is unclear, but for those markets outside the EU trading conditions are unchanged so there is less disruption.
“So, the ideal business to invest in is one that doesn’t move goods across borders and has a high proportion of business outside the EU. Generally, this is where many of the growth businesses focus and, in reality, trading within Europe for these businesses also comes with less regulatory hassle.”
John Glencross, CEO of Calculus Capital which manages Calculus VCT, said: “Clearly it would be helpful to have greater certainty. As I look at our portfolio, however, by and large, exporting to the rest of the EU is not an important market. It has always been difficult for small businesses to sell to other European countries. Even pre-Brexit, the US, Asia and Middle East are more important markets. Where uncertainty is biting, however, is in the status of EU nationals who work for UK companies. Their status post-Brexit needs to be settled quickly.”
Jo Oliver, manager of Octopus Titan VCT, said: “Uncertainty isn’t good for any business. However, it does create opportunity for companies that are nimble and adaptable such as early-stage businesses.
“Many of these are deliberately creating companies that can be global from the start, due to enabling technology such as smartphones and cloud computing. Our single greatest concern when it comes to Brexit is the importance of being able to access talent and the UK continuing to be a leader in innovation and entrepreneurship.”
“So, the ideal business to invest in is one that doesn’t move goods across borders and has a high proportion of business outside the EU.”
David Hall, managing director of YFM Equity Partners which manages the British Smaller Companies VCTs
Where are managers finding opportunities?
Ian McLennan, manager of the Triple Point VCTs, said: “Triple Point has funded several of the fastest growing tech innovators in the UK, including Capital-on-Tap which itself uses cutting-edge technology to arrange finance for thousands of UK SMEs. We have invested in a digital health company which uses artificial intelligence to assist NHS GPs and dermatologists in the diagnosis of melanoma skin cancer. We recently deployed funds into a rapidly growing company that provides an end-to-end software service to apprenticeship training providers and universities.”
John Glencross, CEO of Calculus Capital which manages Calculus VCT, said: “Calculus is sector and region diverse, focusing on finding and backing great management teams working in entrepreneurial companies successfully selling real products and services. Not all of our investments are focused in and around London and whilst we do focus on healthcare and technology, we do also have investments within energy, media, consumer and industrials.
“Three examples across tech, healthcare and other sectors:
• Weedingtech (West London) - With increasing concerns over the health impacts of chemical herbicide use, Weedingtech has grown significantly and doubled its turnover since Calculus Capital’s first investment in 2016. Users of its herbicide-free, non-toxic weed control foam include municipal authorities in New York, London, Munich, Barcelona and many others.
• Blu Wireless Technology (Bristol) - Blu Wireless Technology is developing the latest ultra-fast internet and wireless-enabled technology. The company was named by the European Commission in 2018 as a ‘key innovator’ for its contribution to research on 5G networks and in the same year won UK government contracts for 5G trials.
• Synpromics (Edinburgh) – A world leader in the technology surrounding cell and gene therapy. Its ground-breaking patentable technology provides the control mechanisms that direct the activity of cell and gene.”
Jo Oliver, manager of Octopus Titan VCT, said: “Our focus is on investing in tech-enabled companies with high growth potential across a diverse range of sectors and industries. One example is the AI-powered language learning app, Memrise, which has grown rapidly to more than 35 million users, while another is Sofar Sounds, which hosts intimate music events in cities across the globe every month.”
Has there been any effect from regulatory changes?
Rodney Appiah, director at Foresight which manages the Foresight VCTs, said: “In a word, no. Foresight continues to adopt a sustainable and pragmatic approach to early-stage private equity investing that focuses on backing UK-wide businesses with proven and defensible business models, steered by strong management teams, operating in large, growing and non-cyclical markets. This approach is tried and tested and has been demonstrated over several economic cycles to be the right one for us and our investors. It has also proven to be a financially successful one with Foresight delivering average returns of 2.9x in realisations for investors since 2010.”
Jo Oliver, manager of Octopus Titan VCT, said: “The recent regulatory changes, enabling the investment of £10m per annum in knowledge intensive companies, is positive for Titan. Most of Titan’s investee companies are knowledge intensive and therefore we can capitalise these businesses from an earlier stage, which enables them to invest in research and development.”
John Glencross, CEO of Calculus Capital, which manages Calculus VCT, said: “The Calculus focus has remained consistent: building diversified portfolios of smaller, UK, entrepreneurial growth companies and creating value for our investors through our multi award-winning funds. The regulatory changes have forced the wider industry to follow the same principles we have followed from day one, twenty years ago.”
Outlook for VCTs
John Glencross, CEO of Calculus Capital, which manages Calculus VCT, said: “Even in the midst of Brexit uncertainty, investment activity remains strong. The UK is emerging as a very entrepreneurial nation, particularly in the areas of technology, life sciences and the creative industries. These industries, by and large, sell globally. The Treasury is very focused on encouraging an entrepreneurial economy and this is helping to support activity.”
Ian McLennan, manager of the Triple Point VCTs, said: “The outlook for the business-to-business software companies that our new Venture VCT invests in remains very promising. Innovation is continuing at a rapid pace and we are seeing a new form of corporate innovation where large, established companies increasingly engage with SMEs and start-ups as a core part of their own R&D plans.
“Thus, the corporate sector, under constant pressure to compete and improve efficiency, is open to early adoption of new software products that improve data and processes throughout the enterprise whether it is for customer engagement, resource planning or for administration and accounting. Our Venture Fund, with its emphasis on working with corporates to articulate their needs and investing in the innovative companies best placed to solve these known challenges, is well placed to benefit from this evolution.”
Jo Oliver, manager of Octopus Titan VCT, said: “Despite the market uncertainty we have seen continued demand for VCTs this year – our AIM VCTs closed in record time and there is continued demand for our Titan VCT.”
Rodney Appiah, director at Foresight which manages the Foresight VCTs, said: “I think there are reasons to be cautiously optimistic about 2019. Despite some economic and political headwinds, UK SMEs remain surprisingly resilient in what is an increasingly globalised market. We are seeing a growing confidence in the UK venture capital ecosystem, a maturing fintech sector, a reshaping of our high streets and a reinterpretation of the world of work due to the increased use of technology and the disruptive nature of the sharing economy. In that environment, Foresight believe our approach of seeking out ambitious entrepreneurs with proven and defensible business models remains an attractive one for investors.”
Chinese New Year
Investment company managers on whether the year of the pig will bring fortune or frustration
The 5th of February marked the start of Chinese New Year, ushering in the year of the pig. Pigs are said to be generous and enthusiastic and though they may not stand out from the crowd, they are creatures of action rather than talk.
So how are China-focused fund managers viewing the threat of trade wars, the current state of the Chinese economy and the prospects for their investments? The AIC has gathered comments from managers with significant proportions of their portfolios in the region.
Trade wars damaging but opportunities arise
Robin Parbrook, Fund Manager of Schroder Asian Total Return said: “We remain sceptical of any real let-up in US and China tensions despite Trump’s suggestions that a deal will be completed. As highlighted several times last year, it is clear that US-China tensions are not just about trade, but something much bigger. It involves US perceptions around China’s intellectual property theft, cybercrime, the way China projects its political and financial power via One Belt One Road and China’s desire to dominate key industries via massive state subsidies through Made in China 2025.”
Howard Wang, Fund Manager of JPMorgan Chinese said: “We believe we should see a resolution on tariffs as it is in the interest of both parties.
“However, the political dimension means we do not have strong conviction. We do think that domestic Chinese equities have discounted a very pessimistic outcome: both a trade war and growth slowdown. Consequently, we are beginning to see value in several areas of the A-share market. Whatever the outcome of current negotiations we believe China and the US will increasingly compete in areas of technological innovation from electric vehicles to artificial intelligence.”
Suresh Withana, Managing Partner of Harmony Capital, the investment manager of Adamas Finance Asia said: “At a macro level, the trade war between the US and China has the potential to cause continued, serious, short-term global disruption. However, this disruption may have unexpected benefits for certain regional economies.
“For instance, companies may seek to shift production from China to other Asian countries. Furthermore, if volatility in public markets continues to prevail, we would expect to see both Chinese and Asian SMEs increasing their reliance on private financing sources as they will still require capital to fund ongoing regional growth opportunities. We believe the most exciting investment areas will be those driven by intra-Asian consumption.”
Dale Nicholls, portfolio manager of Fidelity China Special Situations said: “While Chinese exports to the US as a proportion of their total exports globally have been falling for years as China has expanded its global reach and trading partners, increased tariffs will impact the export sector.
“Of greater concern is the broader impact on general sentiment and the prospect of delayed investment by Chinese companies in general. Despite the rumoured prospect of new trade concessions and a possible ceasefire between the two nations, we remain vigilant.”
Chinese growth slowing but expected
Dale Nicholls, portfolio manager of Fidelity China Special Situations said: “China is facing a slowdown, but this is already well documented and the growth rates in China remain the envy of most economies. The authorities’ focus on deleverage has been the main catalyst for a slowdown as this has impacted access to funding and subsequently impacted business and consumer confidence.
“There has been a slowdown in the rate of growth of consumption, particularly in larger durable goods such as cars. This has not been helped by falling markets and the sense that house prices have peaked. However, retail sales are still showing high single digit year-on-year growth despite the decline in car sales and, even with a general economic slowdown, the medium-term prospects for earnings growth remain strong.”
Mike Kerley, Fund Manager of Henderson Far East Income said: “Chinese growth is slowing although not by more than we would have expected. The rising base ensures that the growth of the past cannot be repeated, while the reforms of state-owned enterprises and the clampdown on non-bank credit will put pressure on growth in the short to medium term.
“These headwinds are being offset by measures to promote consumer spending and by tax cuts to corporates and individuals. This should be seen as a positive as the government pursues a policy of sustainability, rather than the old model of pump priming through debt-funded investment. Ultimately, the quantity of growth may slow but the quality will improve.”
Robin Parbrook, Fund Manager of Schroder Asian Total Return said: “The scope for China to undertake major stimulus measures is now much more limited – unless they wish to suspend the effective renminbi peg. We expect the Chinese economy to continue to slow in 2019 as a result of the authorities’ desire to rein in excessive leverage and bring shadow banking back to balance sheets. Given the pegged currency, a current account no longer in surplus and a leaky capital account, we view the monetary options as limited assuming devaluation is not considered an option - this would cause market chaos and global deflation.
“We do expect some fiscal measures to boost consumption but given the size of the economy coupled with high housing and auto ownership rates, such measures are likely to have a limited impact compared with previous efforts. Our base case is for the Chinese economy to slow, but with debt effectively internalised, the immediate triggers for a financial crisis are unlikely to happen. However, one of the major tail risks we see for the Asian region, is a messy unwind of the renminbi peg.”
Suresh Withana, Managing Partner of Harmony Capital, the investment manager of Adamas Finance Asia said: “China’s SMEs already face a significant financing gap but we expect any slowdown in the Chinese economy to further restrict access to traditional financing methods. That being said, we would also expect to see some form of government intervention to increase domestic spending to counteract many of the effects of slower economic growth.”
Howard Wang, Fund Manager of JPMorgan Chinese said: “China has been on the path of slower, but higher quality growth for the last several years. Amid uncertainties in US-China trade negotiations and domestic cyclical headwinds, the government has moderated the pace of financial deleveraging. We expect policymakers to continue to ease and to resort to more coordinated pro-growth policies on both monetary and fiscal fronts, to direct liquidity to the real economy and to cushion for growth.
“The personal and corporate tax cuts, along with more market-oriented reforms around resource allocation, should support domestic demand and private sector productivity. Given the current valuations and bearish sentiment, we are optimistic on the outlook of China equities, in particular onshore China equities.”
Market turbulence producing opportunities
Dale Nicholls, portfolio manager of Fidelity China Special Situations said: “Following a period of market volatility towards the end of 2018, activity in the portfolio has been focused on opportunities that arise during a period of indiscriminate sell-off. Certain sectors are particularly sensitive to market falls, such as insurance and investment companies.
“In many of these types of companies, valuations have dropped to historically low levels that significantly discount their attractive long-term growth prospects. When it comes to insurance, the sector is hugely underpenetrated relative to the West with demand coming from the growing middle class in China. With regards to securities, the long-term prospects in capital markets, particularly for institutions, make securities firms very attractive at these prices.”
Suresh Withana, Managing Partner of Harmony Capital, the investment manager of Adamas Finance Asia said: “2018 was a volatile year for Asian equity markets. However, we continue to see abundant investment opportunities in China and throughout the wider region, particularly in financing companies in the SME sector where there is a significant shortfall of fresh capital available to quality businesses.
“A key regional investment theme that we expect to continue in 2019 is the rise of an increasingly aspirational consumer culture and this should provide increasing SME investment opportunities in healthcare, tourism, consumer and retail businesses and education.”
Mike Kerley, Fund Manager of Henderson Far East Income said: “Around 25% of the portfolio is invested in China, as it is a country that we believe will only grow in corporate stature. Historically, Asia has generally been associated with the mass manufacturing of low-cost products. Now, however, this is changing.
“For the first time we believe China will spend more on R&D this year than the US and, within five years, we think it may spend more than the US and EU combined. This is most prominent in newer sectors such as electric vehicles, renewable energy, healthcare, artificial intelligence and virtual reality – products and services we will embrace in years to come and have the potential to become part of our day-to-day lives.”
Howard Wang, Fund Manager of JPMorgan Chinese said: “We continue to find plenty of attractive investment ideas in consumer, healthcare, and technology. We have taken the market sell-offs as opportunities to add to quality, structural growth names in internet, software and healthcare services.”
Small is mighty
Ian Cowie examines the attractions of investing in the UK's budding, unquoted companies through VCTs
Ian Cowie
High earners and serious savers find it harder to use pensions to keep wealth beyond the grasp of the taxman, since the Treasury tightened the rules.
That’s the bad news. The good news is that very special types of investment company, known as Venture Capital Trusts or VCTs, can help everyone keep more of what we earn and set aside for the future. But it is important to beware the risks as well as the rewards of these funds that invest in small businesses and start-ups because not every acorn grows into an oak. VCT investors earn our tax breaks by surrendering access to our money for five years and running the risk we may never see it again.
However, I know from personal experience how VCTs can attract 30% initial or upfront tax relief and helped me avoid a substantial HM Revenue & Customs (HMRC) bill I faced over five years ago. Since then, according to Morningstar, the two VCTs in which I invested have delivered tax-free share price returns of 56% and 48%, compared to an average of 39% for the VCT Generalist sector.
"VCTs can attract 30% initial or upfront tax relief and helped me avoid a substantial HM Revenue & Customs (HMRC) bill."
Ian Cowie
Less happily, even after the minimum holding period of five years has expired, my VCT shares continue to trade 33% and 19% below their nominal value or the price I paid before taking into account the 30% tax relief I received.
More happily, while my VCTs continue to deliver tax-free yields of 9.24% and 6.25% respectively, I can see no reason to sell. Such high levels of tax-free income are not available elsewhere. However, hopefully looking further out, it is important to remember that VCTs - like individual savings accounts or ISAs - enjoy no exemption from Inheritance Tax (IHT).
Here and now, more people are considering VCTs since the maximum anyone can shelter in a pension was restricted to £40,000 a year. Anyone earning more than £150,000 a year has their maximum pension contribution further reduced by a taper until those earning £210,000 or more are restricted to a maximum pension contribution of £10,000 a year. If, like me, you have already used pension freedoms introduced in 2015 to draw income or capital from your pension in addition to the 25% tax-free lump sum, then the maximum you can subsequently put into this tax shelter is reduced to £4,000 a year.
"No wonder more people are willing to consider VCTs which, like any other investment trust, aim to diminish the risk inherent in equities by diversification."
Ian Cowie
Even people still at work may find their access to pensions effectively restricted if they have been serious savers for many years and the total value of their retirement fund exceeds £1,030,000. This is known as the ‘lifetime allowance’ and pensions worth more than that threshold may be liable to tax at 55% when the saver reaches 75 years of age or dies. No wonder more people are willing to consider VCTs which, like any other investment trust, aim to diminish the risk inherent in equities by diversification.
Like other investment trusts, VCTs are pooled funds whose own shares can be bought and sold on the London Stock Exchange. This structure enables individual investors to share the cost of professional stock selection and spread their money over several underlying companies. The aim is to reduce individual shareholders’ exposure to the risk of setbacks or failure at any one firm and maximise returns.
Investors with personal or professional knowledge in a specialist area may favour one sector over another. In all cases, the maximum VCT investment must not exceed £200,000 a year. Whichever sector seems suitable for you, if any, it is a good idea to seek professional financial advice specific to your individual circumstances before taking any action. As a general rule, because of the risks involved, VCTs should only comprise a small percentage of a diversified portfolio.
